Aware Inc (AWRE) 2007 Q3 法說會逐字稿

Good day, everyone, and welcome to the Aware, Inc. third quarter 2007 earnings release conference call. Today's call is being recorded. At this time I would like to turn the call over to Mr. Keith Farris, Chief Financial Officer. Please go ahead, sir.

Thank you, operator. Good afternoon, and welcome to Aware's third quarter 2007 earnings conference call. With me today is Michael Tzannes, Aware's Chief Executive Officer. Thank you for joining us today. I'll review the financial result for quarter, then Michael will talk about the business and then we'll take questions. A recording of this call will be available on our website at www.Aware.com after the call is completed. First, I'd like to point out, various remarks we may make about future expectations, plans and prospects for the company and the DSL and biometrics markets constitute forward-looking statements for the purposes of the Safe Harbor provisions under the Private Securities Litigation Reform Act of 1995. Actual results may differ materially from those indicated by these forward-looking statements as a result of various important factors, including those discussed in the section titled factors that may affect future results in our annual report on Form 10K for the year ended December 31st, 2006, which is on file with the SEC.

Turning now to the financial results for the third quarter. Revenue for the quarter increased 12% to $7.5 million from $6.7 million in the third quarter of 2006. For the nine months ended September 30, 2007, our revenue increased 12% to $19.7 million compared to $17.6 million for the first nine months of 2006. We report net income and basic and diluted net income per share in accordance with U.S. generally accepted accounting principles, or GAAP, and additionally on a nonGAAP basis. NonGAAP net income where applicable excludes the effect of stock-based compensation expense. The company uses the nonGAAP information internally to evaluate its operating performance and believes these nonGAAP measures are useful to investors as they provide additional insight into the underlying operating results. However, nonGAAP measures are not stated in accordance with, should not be considered in isolation from, and are not a substitute for GAAP measures. A reconciliation of GAAP to nonGAAP results has been included in today's earnings release.

Our GAAP net income for the third quarter of 2007 was $1.034 million or $0.04 per diluted share, which included $305,000 of stock-based compensation charges under the provisions of FAS 123(R). This compared to GAAP net income of $843,000 or $0.03 per diluted share for the third quarter of 2006. Our GAAP net loss for the nine months ended September 30, 2007, was $32,000 or $0.00 per share, compared to net income of $151,000 or $0.01 per diluted share for the same period a year ago. On a nonGAAP basis, net income for the third quarter of 2007, which excludes the effect of stock-based compensation was $1.339 million or $0.05 per diluted share. For the nine months ended September 30, 2007, we had nonGAAP net income excluding the effect of stock-based compensation of $760,000 or $0.03 per share. Product revenue for the third quarter was $5.1 million, up 35% from $3.8 million in the second quarter of 2007 and up 194% from $1.7 million a year ago. The increase in product revenue from the second quarter reflects increased software sales, partially offset by lower DSL test and diagnostic hardware sales. Compared to the third quarter of 2006, the increase of $3.4 million in product revenue reflects increased DSL test and diagnostic hardware and software sales and increased biometric software revenues.

Contract revenue which includes license and engineering service fees was $1.9 million for the quarter, compared to $1.6 million last quarter and $4 million in the third quarter of 2006. The increase in contract revenue in Q3 '07 compared to Q2 '07 is a result of higher license fee revenues associated with the delivery of license technology and engineering services. The decrease in contract revenue compared to the third quarter of 2006 reflects lower patent and license fees received under agreements with our customers. Royalty revenue of $500,000 decreased by $575,000 from Q2 '07 and decreased by $448,000 from the third quarter of 2006. The decrease in royalties reflects decreased chip set sales reported to us by our customers. Third quarter spending was $6.9 million, including $305,000 of stock-based compensation, compared to $7.9 million in the second quarter of 2007 and $6 million in Q3 '06.

The $966,000 decrease from the second quarter of 2007 was primarily due to $789,000 of lower cost of goods related to hardware product revenues and decreased in trade show expense, R&D laboratory materials, R&D and marketing contracting and consultants and patent legal expenses. Higher spending in this quarter compared to last year's third quarter was primarily due to higher cost of goods related to growth and hardware product revenues and compensation increases. We had interest income for the quarter of $512,000. Our available cash and short-term investments were $38.1 million at the end of the September. Receivables were $7.7 million at quarter end. Taking into account collections since September 30th, the receivables balance was consistent with previous quarters, with the majority of the open balance less than 30 days old.

Inventory was $1.4 million at quarter end. This inventory level reflects the growth in our test and diagnostic hardware revenues and supports firm customer orders and long lead time requirements that we have. We have $689,000 of deferred revenue, a slight increase from Q2 '07. Deferred revenue relates to contracts and maintenance agreement. We have no debt. In the third quarter we began to record patent legal expense in G&A rather than in R&D. Prior year numbers have been adjusted for comparative purposes.

As of September 30, 2007, we had repurchased 9,107 shares of common stock under our stock repurchase program. On August 28, 2007, we announced a program authorizing the company to purchase up to $5 million worth of its common stock. These repurchases were made in accordance with rule 10b18 which limits our repurchases to 25% of the average daily trading volume for the preceding four calendar weeks. This average excludes any block purchases we may make. As of September 30th, there were 23,775,720 shares outstanding. At the end of the third quarter, we had 127 full-time employees, 96 of these employees were engineers. This completes my financial commentary. Now I would like to turn the call over to Michael.

Thank you, Keith. Revenues and profits this quarter president highest for Aware since the first quarter of 2001. We're pleased with the progress we made in executing against our goals by leveraging our DSL and biometrics technologies and product offerings into market presence. The DSL and biometric markets are exhibiting healthy growth and our exposure to opportunities within these markets has improved. Product revenue hit a record of over $5 million this quarter. This revenue reflects the success our biometric software products are having, as well as success we are having in our test and diagnostics hardware and software products. Gross margins on product revenue are improved over last quarter because of the higher percentage because of software in the product revenue mix. And the gross margin on hardware products was within our target range of 35% to 45%. Contract revenues reflected DSL chip development activities with our existing customers. Development and support for ADSL2+ and/or VDSL2 chips with Thomson, Infineon, PMC-Sierra, Ikanos and one unannounced customer all contributed to our contract revenues. Royalty revenues reflected primarily sales of ADSL2+ CP chip sets from Ikanos and ADSL2+ CO and CPE chip sets from Infineon and to a lesser extent VDSL2 chips from Infineon. VDSL2 deployments are still at an early stage and volume sales opportunities are currently limited to a few geographic locations.

Turning to biometrics for a moment. Our data processing software which includes NISTPack and new CaptureSuite product were especially strong this quarter reflecting our value propositions in solutions for biometric enrollment applications. The Department of State announced they are using our CaptureSuite products for visa applications in U.S. embassies around the world. We continue to improve our market presence in biometrics and expect to see continued growth and success in this part of our business going forward. In test and diagnostics, the roll of -- the roll-out of ADSL2+ and VDSL2 networks for triple play including IPTV is increasing demand for solutions that prequalify provision and troubleshoot DSL. Our products are well positioned within the hand held and test head manufacturers as well as network equipment suppliers. We estimate that our test and diagnostic software has been used to prequalify our provision in excess of one million DSL lines this year through OEM relationships we have with DSLAM and test head suppliers. One of our OEM began shipping handhelds to a European deployment and we expect other hand held suppliers to begin shipping products in the coming quarters. In general in test and diagnostics we have a strong set of customer relationships and good portfolio of hardware and software products giving us broad exposure to multiple opportunities.

In DSL, the market continues to transition to higher speeds in the access network using a ADSL2+ and VDSL2 for the delivery of triple play services and IPTV. I attended the DSL world forum in Berlin last month and was very impressed with the focus the phone companies have on delivering content using their DSL networks. The use of ADSL2+ and VDSL2 as a means to deliver triple play services for the foreseeable future is a foregone conclusion. Our role as a pioneer in these technologies is well established through our reputation of standards bodies and through our product developments represented in our StratiPHY product line. As the next generation of DSL deployment take hold, we were in a position to take value to our shareholders through our strong intellectual position as a licensing company and as a supplier of test and diagnostics hardware and software. We executed against our strategy and have been able to leverage strong foundations in core technology and know-how into leadership technology and product positions, which are providing us broad market exposure in the DSL and biometrics markets. Our goal is for each of our product lines through licensing and software business models to be profitable.

In the first nine months of this year we generated a healthy balance of revenues from DSL licensing, test and diagnostics hardware and software and biometrics and medical imaging software. Based upon the size of the market and the strength of our product offerings in these markets we see each of these three product lines capable of growing to annual revenues of $15 million to $20 million over the next few years. Our internal plan is to achieve operating margins that grow as revenues grow with the goal of exceeding 20% in the next few years. Our core strategy is to work toward executing on our growth plans by continuing to innovate with technology and product developments to further improve shareholder value.

Turning to guidance for a moment. We are reiterating our guidance for the 2007 calendar year, which was $26 million to $30 million in revenues and $0.01 to $0.10 in EPS. We are cautiously optimistic that we will be able to make guidance. If we successfully execute and outperform on some of our internal goals we will be in a position to exceed the top end of our guidance for the year. We are very excited about Aware's position in the DSL and biometrics market. 2007 has been a break-out year for our test and diagnostics and biometrics products. These product lines along with the mature and highly leveraged DSL licensing product line have set us up for success going forward. With that, we'll open up the call to your questions.

Thank you. (OPERATOR INSTRUCTIONS) And we'll pause for a brief moment. And we will take our first question from Joel Achramowicz.

Good afternoon, Michael. This is Joel Achramowicz.

Hi. Joel.

Hello. Congratulations, good quarter. Nice to see that you are reiterating guidance. I have a busy afternoon, but a number of companies called. I wanted to ask you, it sounds like even though the royalty of revenues were low, it simply in a reflective of the cyclical nature of the DSL industry in that you fully expect it to inevitably that the DSL port ramp will occur and that you will leverage your intellectual property in that regard. Would you comment on that?

Yes. You bet. We have, I think you know well, but we have some very good exposure to both the ADSL2+ and VDSL markets. Today that that exposure is primarily in Europe. But going forward, through both existing customers and some new customers that we are believe are going to be coming online with successful products, we're going to see opportunities we think in Japan, Korea, China, India, potentially other parts of Europe. We also think we have some opportunities in the U.S. and Canadian markets. So with new products coming into the market from PMC, Thomson, as two examples. There's one unannounced customer as well that we expect will be entering the market. Over the next three to six months I think we will see an improvement in our exposure to this market.

And as far as your position in the security area, sounds like you're going to continue to build out that business and invest in it. Sounds like it's really starting to take hold and you are getting traction in that regard.

Yes, it's been a very gratifying year from the perspective of seeing traction with some of the new products that we introduced. Clearly, it's an area -- it's an industry that is exhibiting very healthy growth. Our position in it is very strong through a number of OEM relationships that we have. And we think that just like you said when we were in a good position to continue to see growth there.

Well, I'm encouraged with the progress and good luck going forward.

Alright. Thank you, Joel.

Next we will hear from Lilly Wu.

Yes, hi, thanks. Just a few quick questions. The biometric software revenue is that one time licenses or is there recurrent component to that?

It's really a software seat license.

Okay.

So there is -- it's not a -- there is a maintenance aspect to it that is relatively small, I would say. So it's as -- so as an example one of the classic types of applications will be involved in biometric enrollment application where machines, PCs are used to capture biometric data and store it and perform various transactions with it. We will sale software license for each (inaudible) that is used.

And that license then is sort of -- is that's just a license to use that software, a perpetual software to use that software?

For that PC.

Right. So then there is a small maintenance component, so -- but basically that's a one time sale?

Correct, yes.

Okay. And that would be the bulk of the biometric software revenue that was reported this quarter?

That's our primary business model in that area, yes. And it has been for years. So the growth you are seeing in those products and that product line is a consequence of additional sales of software into those types of applications. The primary areas we are seeing growth at this point are in border control, the personal ID verification programs that the government is putting in place. Generally biometrically enabled IDs are becoming very widely used. So we have software solutions that address a number of those applications.

Okay. And on the VDL -- VDSL2 side, it sounds like the revenues primarily were ADSL2+ and only a modest amount on VDSL2. Is that -- I think that's what I heard?

That's correct. So we had in the past and I think we talked about this a bit last quarter, in the first deployment of central office equipment in Germany we had very good exposure through one of our customers. And at this point it looks like there is going to be a follow-on. I attended a number of presentations on this at the conference I mentioned in Berlin. Deutsche Telecom is very confident they're going to be able to deliver service now to a number of subscribers. They actually relaunched their marketing program which involved HDTV programs as long as you actually buy the VDSL version of their service and access to certain soccer games. So they've bundled content and sort of entertainment quality together as part of their pitch to attract customers. But they expect to start adding customers significantly so we would start to see, we expect, sales from our customer for the customer side of that deployment. So the first part of this year we didn't see as much VDSL as we had seen in the past. ADSL, there are so many countries deploying ADSL and we have exposure to a much larger number of deployments there where you don't have quite as lumpy a circumstance as you do in VDSL. Over time, of course, VDSL will be as widely used as ADSL and you won't have these single events that dictate a particular quarter's performance.

And can you just summarize again the ADSL2+ deployments? I believe in the past it was still primarily Asia and Europe focused, but can you be more --

That's still correct.

-- country specific in terms of the programs that you are involved with?

Well, the largest one on the CPE side, actually there is a number of European countries through both Infineon and Ikanos. And Infineon also has both central office and customer premise deployments in other parts of the world. Going forward we think that there is good exposure through those customers as well as PMC-Sierra, Thomson, one of the unannounced customers we have in Japan, in India, in China, and in some the other European deployments as well as in the U.S. market and the Canadian market.

Okay. Okay. So basically that's a much broader based exposure.

Sure. Well, that, yes, what I was speaking to there wasn't specifically ADSL2+ only. There are some VDSL2 opportunities in there as well.

Okay. And is it common because say for example PMC-Sierra, Thomson and Atmel, we've discussed this contract customers for over a year now. But I'm not aware that you ever mentioned them as royalties contributors.

Yes. They still have not been.

Okay. Is it common they take this long to bring it to market?

Is it -- well, we have seen it happen a number of times. So I guess we are not and they are not necessarily pleased with that. But I don't think it's uncommon that it's difficult to break into these markets. They tend to have a lot of inertia associated with them. On the flip side once you do get in you tend to maintain a presence for a long period of time.

What generally speaking is the hurdle that they face? Is it competition from nonAware technology say from Broadcom, or other companies, or is it --

Yes. I don't think you can point to one thing. It's competition potentially from incumbents who may have deployed, because in the case of PMC-Sierra, anyway, they are a new entrant into the market. So they are dealing with competition from both licensees of ours as well as companies like Broadcom as you mentioned. So they're -- they don't have an incumbent position. So I think that's a challenge. Of course, what they try to do is leverage relationships that they have with modem and gateway suppliers that have gone in other areas, in other technology areas. I think often there is geographical preferences in some parts of the world, familiarity with certain vendors, but I don't think you can point to any specific hurdle.

Obviously the combination sort of when a deployment changes its nature from say ADSL to ADSL2+, or from one vendor at the modem level or the network equipment level to another vendor, those are times when there are opportunities for new solutions to enter those markets. Those don't happen frequently. So you sort of have to time it right. Your product obviously has to be competitive, and your pricing has to be competitive, and your performance has to be competitive. But it's a combination of things that I think makes it a challenging market to enter.

But they're still committed to the product and program developments. They are not leading the market, I presume.

That's correct. Yes, they are.

Okay. And one last question on the financial side, it looks like net cash usage was down $1 million in the quarter. Is that due to the stock buy-backs, or was there any Cap Ex, or was it operating cash flow? Or could you just go through the cash on hand decline by $1 million, what --

Sure. That was basically due to the operating cash flow. The stock buy-back amounted to $38,000. So that was primarily reflected cash from operating activities.

Okay. So the $1 million -- and that's primarily a more back-end loaded quarter where collections were pushed into the current quarter, is that right?

Well, that's correct. We did have some large invoices that were collected after the quarter end.

Okay. Okay. Great. Thank you very much.

Thank you, Lilly.

We will next hear from Mike Easson.

Good afternoon, gentlemen. And first of all, congratulations on the strong quarter and encouraging outlook.

Thank you, Mike.

Michael, your recent trip to Berlin, coming out of the conference, can you comment on any deployment and announcements, and potentially any equipment on either side of the link on the CPE side or on the DSLAM side that may be using Aware technology?

Let me think about that. Well, I think I know of some that were not using Aware technology. So I could -- those came to mind. So I will comment on those while I try to think about the rest of your question. We did see an announcement that Ericsson using a Broadcom was going to be deploying to certain parts of the Deutsche Telecom deployment. And I think Infineon -- I spoke with both Infineon and Ikanos about opportunities, but I'm not sure how public those were. But suffice it to say there wasn't anything earth shattering or anything of a large nature that came out of that show for any of our customers. PMC-Sierra was there with a very impressive booth and a very nice presentation, marketing very aggressively into a number of places, but I don't think they announced any of their successes yet. And Thomson had a very good presentation demonstrate actually of a new product, a VDSL product which is a high end video gateway where they were demonstrating HDTV and voice and data all on a single platform using the VDSL license from us. And I know Thomson is confident that they're going to see business in particular in the ADSL area in the near future, but I'm not sure they announced that just yet.

The Thomson chip, you said the product they displayed or [demoed] at the conference was a VDSL solution.

That's right.

They also have a historic ADSL solution.

That's correct.

Okay. And if I could turn back to the guidance for a second. Last quarter you offered a fairly wide EPS range which I think was reiterated here today. Based on uncertainty in the mix and in the second half of the year, given your results in the gross margins back up in the high [60%], I can hopefully assume that mix shift back away from the hardware test platforms?

Well, one of the good things about the test business this year, test and diag business is obviously it's shown very significant improvement revenue-wise and market position-wise and customer relationship-wise and everything over last year. It's been just very, very strong growth. It's still a fairly new product line and a fairly new set of opportunities. So last year, last quarter was very hardware intensive. This quarter was a lot more software. I think in general over time we expect that to be a balance of software and hardware. But it's a little too early right now in terms of the sort of maturity of the deployments and the maturity of some of the relationships we have to be able to say it's going to be like it was last quarter, next quarter because there's just only -- there is only a few samples of significant deployments that we are participating in.

So you see some variability or some --

Yes. I don't want to -- I am not trying to tell you that it's going to -- I'm not going to tell you about anything of next quarter, or this quarter, Q4. I think in general over time it will be a similar balance to what we are seeing this quarter. Or that would be our goal for sure to see a healthy balance of hardware and software.

Understood. Okay. Just one last question in your comments you alluded to potential for and exceeding the high end of your guidance this year. Although, obviously, I won't hold you to that, but what would have to happen for that to occur?

If it occurs obviously we will have enough opportunity to speak to the specifics and hopefully we will be able to do that. Generally, I will speak sort of generally here. We have a number of opportunities to capitalize on core technology and know-how that we developed over the last 15-plus years. Obviously, DSL has been an area we have been strong in. And we have a strong expertise and know-how foundation in the company for developing licensable chip designs for semiconductor companies and StratiPHY's been the DSL product there. But we do see opportunities to leverage these core assets in ways -- in addition to inside the DSL market, in other markets as well. So it's -- there are some exciting things going on and hopefully we will be able to talk about them in more detail in the near future.

Great. Congratulations again. I will turn it over here.

Alright. Thanks, Mike.

Next we will hear from [Tom Curdo].

Mike, first of all, hello, guys.

Hello.

My question -- I have couple and I will get back in the queue if you feel I'm overdoing it, but -- is a follow on to Mike's question about your trip to Berlin. You said that Ericsson and there has been rumors about this, is using a Broadcom chip to -- and will be supplying Deutsche Telecom. Can you -- do you know what chip that is? Is that a VDSL2 chip?

Yes, it is. Yes. So they announced -- there had been a number of rumors that we had heard as well over the last probably six months that Broadcom was going to be entering in the -- in a fairly aggressive way enter the VDSL market. And from one of our customer's perspectives I can just relay that in their opinion the market will primarily be Broadcom and themselves. That's what they see the landscape as shaping up to be.

I'm sorry, did you say Infineon.

I didn't say who it was. But it's a customer who is aggressively going after the VDSL2 market as well. And I think their perspective is primarily a European perspective because that's where they've been strongest. We'd -- as you mentioned we had seen -- we had heard rumors to this effect, and what I think Broadcom effectively did was use this conference as a opportunity to announce several -- their progress in entering the VDSL market and that was one of the announcements that obviously caught our attention because we know that part of the future that we are looking at inside Europe has been with through Infineon at Deutsche telecom. And we expect as they do that that will continue to be significant opportunity for them. But obviously now there is a second vendor in there.

Okay. So this is a VDSL2 chip.

That's right.

And they're a competitor of yours, is that still a case? Broadcom?

Well, they are directly a competitor of Infineon's.

So they are not using Broadcom is not using Aware technology?

That's correct. They are not licensees of our StratiPHY product.

So one could be a little critical of your aggressiveness on your patents, copyrights, etc. Rambus, for instance, is very aggressive. Is Broadcom clearly using the technology that is different than what your patents and everything else intellectual property covers.

No. They are using a standard compliant technology and our belief is and we haven't gone in and tested the litigation or patent waters like Rambus has. But our belief is we have a strong patent position in that standard technology that they are using. But at this point we have elected not to pursue a litigation path as a means to monetize these assets because we think there are other ways to do so.

And I don't disagree with that. But so could you say whether you are having conversations with Broadcom as to --

No, I can't say.

Okay. Okay. And another question would be, it's November 1st -- question on royalties. It's November 1st. So I think because of the delay you have some clarification on Q4 royalties. Will they be up and can you quantify that in some way?

Well, first of all we don't actually have any clarification yet. We usually get royalty reports right at the end of our quarter just because of the time it takes for our customers to report and pay to us. We typically get those -- in this quarter it would be in December. And our visibility through the customer base is pretty limited in terms of exactly what they are selling and where they are selling to. And that's not something that we probe too much because it's actually very sensitive competitive information, because often various customers of ours are competitive with one another. So we don't have much visibility on that. Generally speaking and not so much to this quarter versus last quarter, but generally speaking I expect our position in the -- in both the ADSL2+ and VDSL2 markets will improve going forward and I talked about why I thought that a little -- a few times already. We have new customers entering the market. There are new opportunities that both existing and new customers are going after. So I think that over time the evidence will -- the evidence there is that the royalties will improve. Whether it's going to happen this quarter or not I really don't know, Tom.

Okay. I had the impression that almost like in the first month after the quarter your royalty customer started to report to you what they did in the -- in this case the third quarter.

Yes. It depends. Sometimes they do, sometimes they don't. But generally we don't know until the last month of the quarter what the royalties are going to be.

Okay. Okay. Okay. Let me try one more. Ikanos, they announced this big deal about outsourcing their back-end physical layer design and how much money they are going to save. And I had a conflict listening to the live conference call, but I did listen to the replay and the whole issue never came up. What does this mean to Aware?

It means nothing to Aware. This is not related to the technology that we develop and license. This is a service that they decided to go out of their company to get which has to do with physically designing a piece of silicon. It doesn't have much to do with the application. It's not specific to DSL or anything else. It doesn't have anything to do with us. I'm going to ask you -- I've got a note here that there are other people in the queue, Tom.

I'm sorry. That was it.

No problem. Thank you.

Next we will go to Bob Lee.

Hi, good afternoon. Thanks for taking my question here. Michael, can you give us an update on the TI Infineon front from the second quarter conference call?

Not really. The deal has closed as I understand it, according to folks I spoke with at Infineon. I don't think we actually checked that, Keith, have we checked? But I believe it's closed. From our perspective, it's a -- it's an opportunity for a number of the products that TI was selling, which were primarily ADSL2+ focused, to be transitioned to products that Infineon and Aware have developed over the years which have both ADSL2+ and VDSL2. I still believe that's the opportunity there. I don't think it's something -- I've never thought it as something that will happen overnight. I think it will take some time for that transition to take place. I think Infineon feels very good about this because I think it give them a good critical mass in the market. If you look at the market share, the piece -- these two companies now that they are combined can have. And the focus that TI had was really on the CPE side and Infineon was always strongest on CO side, so I think it was complementary in that regard as well. Our relationship with Infineon has not changed at all as a result of that. At least to date. And we have no issue or concern that it's going to change.

I -- you just mentioned earlier during your prepared remarks that there may be some strength -- opportunities -- I'm sorry, opportunities in the U.S. market. And TI was pretty strong and the CEP on the U.S. side. So I was thinking that was something you believed --

That actually wasn't what I was thinking of again because I think that's probably a longer term opportunity. So I think there are nearer term opportunities. But that would be one as well over probably a longer period of time.

Okay. Can you differentiate your StratiPHY product -- I guess your product offering versus the Broadcom chip set in terms of performance?

In ADSL and VDSL, their VDSL products are fairly new. So I'm not sure we have as good a -- a set of benchmarks. In ADSL2+ where they have been in the market for some time as have we, I think the performance is generally comparable. I think we were probably better in some areas and they are probably better in other areas. A lot of this market once you get over a pretty high bar which is certain data rates over certain distances, the differentiation isn't so much in the physical layer performance itself. It's in the integration of the DSL functionality with other functionalities. So -- and this is one of the reasons the licensing company can be in our view very successful here, because if it was the physical layer that was differentiating things it would be difficult for people to license that as opposed to do it themselves. So in the central office side it's how many of these chips can you put on a single chip for multi-port and how effective is your analog design.

So it's sort of the packaging of the solution. On the customer premise side it's the integration of DSL functionality with other things like network processors, increasing the (inaudible) passive optical networks, being part in certain parts of the world. Video processing is becoming important. Wi-Fi in some applications is something that a modem or gateway supplier going to want to buy a solution that does multiple pieces of functionality including DSL and these other things. So I think we are -- we were earlier to market than they were. On VDSL2. So I think we managed to pick up some significant wins in some of the early markets. But generally speaking especially when you talk about Broadcom, they are going to have a part or a device that meets the performance requirements just like ours does.

Thanks. Fair enough. If I may add two more here quickly. More housekeeping is, the sales in the DSL test and diagnostics hardware, was that lower sequentially over the second quarter, just to clarify?

Hardware sales were lower this quarter than last quarter. That's right.

And the way to think about this going forward is that the hardware sales precursor any of the software sales and do you see any kind of --

Yes. That's true to some extent. There are some opportunities on the hardware side where it's a hardware sale and it's -- there may not be a follow-on software opportunity. We are interested in the latter. We were interested in those opportunities where we can sell both hardware and software. But, for example, one of the newer areas that we are starting to see success in is in the hand held market. I mentioned that one of our customers was starting to deploy into a -- sell hand helds into a European deployment. And that right now is a hardware sale and we hope it involves software as well. But in some cases hand helds might only be hardware opportunities for us. So it's a pretty new market, Bob, and there is a lot of different types of opportunities out there. Our goal is to find a nice balance of hardware and software.

Okay. Fair enough. And then lastly, the guidance that you gave for EPS, is that based on nonGAAP?

Yes -- no GAAP.

GAAP? Okay. So I mean, the first nine month being break even, there has to be significant headwinds in the fourth quarter for you to make that upper bound, right, in order to do that?

Right. So as I said, it would be some thing happening. Some executing on some things that are above and beyond our current internal goals. But they are possible.

Okay. Alright. Thank you very much.

Thank you.

Next we will go to [Abhina Shing].

Yes. Hi, good afternoon, and thanks for taking my question here. Just a couple of questions. I just take you guys back to the first quarter earnings conference call where you mentioned that you expected the contract revenue guidance, did the contract revenue to be around $10 million to $12 million considering the nine months, would you have a revised guidance for that having made it on $5 million, $5.5 million so far?

Yes, we don't think we're going to be at that level any more. And I think last quarter when we moved from $30 million to a range of $26 million to $30 million, clearly a lot of that range is coming from the contract and to some extent royalty revenues where there was -- things weren't performing as well as we originally thought they would. Obviously on the flip side, product revenues were performing quite well and outperforming in some cases some of our internal goals.

Okay. And another thing about the biometrics revenue, you mentioned that in the last quarter conference call around $700,000 got missed in the second quarter. So was that a part of this quarter's revenue?

Yes, it was.

Okay.

And actually came in right after the end of the quarter so it was at the beginning of this quarter.

Okay. And one last question from me and I will get back into the queue. Just take you back to the comments on the Deutsche Telecom deployment and then you mentioned you are expecting some kind of rebound in that deployment.

Yes.

So just wanted to get an idea about what time line are you looking at? Are you looking at rebound to happen somewhere in the next quarter or two, or --

Yes, I think it's such a tough question to answer because the phone companies I think they are well intentioned. You can look at AT&Ts discussions about what they are going to do with lightspeed or whatever they are calling the program, U-Verse these days. I don't think they are trying to tell the truth when they say they intend to do this. But these are challenging large deployments and they -- to really matter they have to hit a mass market kind of volume. From what I understand, and this is in the audience as a member of a presentation, Deutsche Telecom is very aggressively going after a pretty slick content plus technology offering. And we know that they've deployed a large number of head end units, so they have the capacity to turn these subscribers on. And clearly they've spent a lot of time and money getting ready to do that. So I think they want to do this reasonably quickly. And I think it's going to depend on -- I don't know what really might hold it back. But they clearly are very interested in doing this and are also interested in expanding the footprint of the head ends and the central office units into other parts of their country. So both sides of the -- of that network are still in pretty heavy investment and development mode.

Okay. And one more last question, if you guys will allow me. Will you have the customer concentration numbers in terms of how much the top two, top three accounted for? Would you have those numbers with you?

We typically do that on an annual basis. We don't usually do that on a quarterly basis.

Okay. Okay. Thank you, gentlemen.

Thank you very much.

And our last question will come from Stanley Cohen.

Hi, everyone. Congratulations on a very good quarter.

Thanks, Stanley.

Just a line of question about test and diagnostics first. Was the majority of the revenue from test/diag indirectly from customers that you're still selling to TELUS still?

No.

Came from two or three customers this quarter predominantly?

Came from -- yes.

Okay. So let's say you test and diagnostics was about $3 million given the way it works out. And I understand that you are lumpy here and there. But you are already on a $12 million run rate. It's not the largest carrier, largest customer TELUS which is on the second largest carrier in the small country of 32 million people. Why is your long-term goal in that market only $15 million to $20 million a year?

Well, I said the next few years, first of all.

Even more so.

And I made a general statement about all three of the businesses. I suppose if I were to pick each one -- I think I would make the statement, Stanley, because as I've said a few times today, it's not at a -- it doesn't have the track record and the history to be able to say you did X-million this quarter, therefore you will do four times X-million the next four quarters.

I understand, but my logic is you are selling to a small amount of carriers and the market is still early and the revenue being at the level it is, there is a potential for it to be greater than --

That's true.You are right. There is a potential for that.

Yes. Quite a bit. If you get some of the larger --- and customers are getting with the larger carrier.

And again I think the -- as I also said a few times, our real goal here is to accomplish a position in the market which is a balance of hardware and software. So the way you will grow revenues is rapidly is potentially with hardware sales which aren't -- not something we were going to turn away from, but they're not the primary -- they aren't the only thing we are going after.

Right. And even though --

For obvious reasons.

It's lower margins, it's money to the bottom line.

Yes, it is.

I assume the handle stuff was relatively slow this quarter.

Yes. I think -- yes, it was.

The (inaudible) resells, anything familiar?

Some progress. Not -- it hasn't been a primary revenue generator yet.

Okay. On the contract side, you threw in a comment when you were answering Joel Achramowicz's question about currently working with several new customers. You sort of just like threw that into the side. Do they have a shot of materializing in the next few quarters and that --

I think I was referring to customers that are not necessarily new to the investment community, but who have not entered the market yet. So PMC-Sierra and Thomson, for example.

You work on new products with them?

Well, existing -- products that have in many cases have been announced, but we're still working on getting them deployed or they are working on getting deployed into the market.

Okay. Is there any revenue yet from VDSL3?

Not yet. But when we look at opportunities going forward, clearly that is one, the AFE continues to -- analog front end continues to be marketed in some spots and being well received. So both existing and new customers are I think are looking at that as a real asset that we can deliver. And then as I mentioned sort of in passing I think there are some opportunities outside of DSL that we might be able to get into over the near longer term.

Can you elaborate on that in any way, or --

Not yet. I would like to see it take a little more shape before we --

And the customer you announced a year or so ago there may be some potential patent royalties from? Will that materialize ever, or is that --

Yes, I think we will be able to talk about that next year in some more detail.

Really? Okay. And finally on the royalty front, someone asked you a question about other carriers who are making VDSL2 deployments that are indirectly using chips -- your customers. I believe and I could be wrong about this, but Qwest is starting deployment and they are using some (inaudible) equipment which uses the Infineon chip. Do you know anything about that?

I've heard rumors to that effect, so if you've seen that announced somewhere that would be --

I probably saw the same stuff you saw.

-- that would be good news. I think Atran is one of Infineon's customers. I don't think they only use Infineon chips but I know they use Infineon chips. If Atran has success in their access equipment, that may involve us. And then we know that Infineon has had some success in Korea. I mentioned I think briefly that I know some things that some of our customers are involved in, but I'm not sure they've announced them yet so I'm not going to talk about them.

Actually that was my question about the Infineon's deployment in Korea, obviously we haven't seen revenue from it. Is that deployment still going to happen?

I think it is. And we haven't -- we certainly haven't seen significant revenue from it yet. But I believe both Korea and Japan -- and Japan are going to be transitioning to VDSL2, and I think we have some opportunities there through Infineon and through others.

Okay. And finally one last question, the biometric area, you never mentioned anything about the biometrics, but the compression software you sell to the health care market.

Yes. Medical imaging.

Yes. I've noticed a lot of activity at the trade show in that. Is that business growing? Is that still to come?

It's got a similar -- it's probably a little even behind the test and diagnostics sort of level of maturity. So we have some products there that have to do with managing medical images. I will just generalize at this point and maybe we will talk about that more in the future. And we seen some revenue in the last -- both this year and last year. It's not a significant amount of revenue yet. But we do see some opportunities there and we are using really the same business model as we are in the biometrics and now the test and diagnostic software area, so I think we can leverage a lot of know-how there. So it's a distant fourth in terms of its revenue contribution. But it has some good potential upside over the long term.

Okay. Great. Thanks a lot, Michael.

All right, Stanley.

That concludes the question and answer session. I will now turn it back over to Mr. Tzannes and Mr. Farris.

Thank you very much. We are going to be at the AeA Classic Conference. John Kerr, who is the Chairman of the company, and I will be there. We present on Tuesday afternoon and Wednesday morning. If you are in the Monterey area and know of this conference, it's a terrific conference. And hopefully we will see some of you there, and we will talk to you next quarter. Thank you very much.

Thank you for participating in the Aware conference call. You may now disconnect.